China’s Tax Avoidance Crackdown Targets MNCs

The profitability of multinational corporations (MNCs) will be the main focus of Chinese tax authorities during the annual inspection of related-party transactions in 2012, according to a recent report by Shanghai Securities News.

China’s State Administration of Taxation (SAT) aims to establish a comprehensive enterprise index system this year, which will contain nationwide information on both related-party transactions and contemporaneous documentation. Based on the system, the SAT will conduct comparative analyses on related-party transactions conducted in different industrial sectors, tax years, and geographical areas.

Such area-by-area and sector-by-sector analyses will help the tax administration define enterprises with comparatively low profitability levels and improve the understanding of tax avoidance modes used in different sectors. During the past few years, the SAT has effectively strengthened their anti-avoidance inspection skills in the service sectors, especially in retail, real estate and shipping. In the future, more sector-specific anti-avoidance measures will likely be rolled out.

In addition, starting this month, China will implement new laws to regulate the workflow of special taxation adjustments. The country also plans to issue more detailed provisions at a later date to tighten the supervision on foreign-invested enterprises, general tax avoidance, and tax avoidance through tax havens.

Transfer pricing is critical to MNCs because it determines in large part the taxable profits of associated enterprises in different tax jurisdictions. In China’s case, the SAT requires companies to present an annual report on transactions between associated entities, and (like many other countries) the tax administration has the right to adjust prices of those transactions if it perceives they have been charged outside an arm’s length range.

Under China’s transfer pricing rules, it is relatively easy for two companies to be considered “associated enterprises.” Additionally, due to the very limited levels of tax appeal in the country, taxpayers may want to avoid a tax dispute from going to the assessment stage. Therefore, it is important for companies to assess their risks and document their transfer pricing policies in advance.

Another notable development in China during the past few years is that the tax authorities have attached increasing importance on associated equity and intangibles – instead of only traditional types of trading – during their anti-avoidance inspections. Such trends may put forward a higher requirement in companies’ transfer pricing documentation preparation.

Nowadays, more and more companies operating in China are considering resorting to bilateral agreements with the SAT to fix future applications of transfer pricing policies and mitigate risks from possible taxation adjustments. By the end of last year, more than 120 enterprises have entered the application process for bilateral advance pricing agreements and bilateral consultations on transfer pricing corresponding adjustments.

Going forward, the Chinese government will likely make more of an effort to improve its anti-avoidance skills as it continues to see taxation adjustments become an important source of tax revenues. In 2011 for instance, China’s tax avoidance crackdown contributed RMB23.9 billion to the country’s total tax revenue increase.

This article was written for the China business news site, China-briefing.com.

Dezan Shira & Associates specialise in foreign direct investment in China, and maintain accountants in Shanghai, Beijing and other major cities.